Polytechnique University of the Philippines

Sto. Tomas Branch

Inventory
Model
CHAPTER 4

Jhun Jhun M. Quiatchon, MBA

 LEARNING
• OBJECTIVES
At the end of this chapter, the student should
be able to:
1. Discuss the economic order quantity model;
2. Compute total annual inventory cost; and
3. Explain when to make an order for
inventory replacement.
 “Inventory is money sitting around in
another form.”
Overview -Rhonda Adams, USA Today
Definition • Inventories are
goods intended for
sale. They are
purchased from
suppliers and sold to
customers.
Economic Order Quantity Model
-developed by F. W. Harris in 1915, is
a deterministic inventory model,
which is applicable when there is a
constant rate of demand for a
product.

How much goods should be

ordered?
When should an order be
made?
 Assumptions of the
EOQ Model
• The demand is considered normal and
constant.
• The ordering cost, carrying cost, and
purchase price are constant and not
dependent to the quantity ordered.
• Shortages do not exist.
• The lead time is constant.
• The order quantity is the same for each
other.
Ordering Cost
It is the cost when placing
an order for a product.
Carrying Cost

It is cost associated with

maintaining an inventory, .
EOQ Formula
EOQ
Where:
EOQ - Economic Order Quantity
D – Annual Demand
OC - Ordering Cost per Unit
CC – Carrying Cost per Unit
Total Inventory Cost Formula
TAIC = TOC – TCC

Where:
TAIC – Total Annual Inventory End
TOC – Total Ordering Cost
TCC – Total Carrying Cost
Total Carrying Cost Formula
TCC = AI x CC
Where:
TCC – Total Carrying Cost
AI – Average Inventory
CC – Carrying Cost per Unit
Average Inventory Level Formula

AI =
Total Ordering Cost Formula
TOC = (D ÷ EOQ) (OC)
Where:
TOC – Total Ordering Cost
D – Annual Demand
EOQ – Economic Order Quantity
OC – Ordering Cost per Unit
Problem
Izzy Processing Company has an annual average requirement of
50,000 units of its product. It has been estimated that the
ordering cost is Php80.00 per order and that the carrying cost
per unit of inventory is Php2.00

Required
1. Economic order quantity
2. Average inventory level
3. Total carrying cost
4. Total ordering cost
5. Total annual inventory cost
EOQ

EOQ
EOQ
EOQ units
This means that Izzy Processing Company shall place
2,000 units of the product every time it makes an order.
Average Inventory Level

AI =
AI =
AI =1,000
Total Carrying Cost

TCC = AI x CC
TCC = 1,000 x 2
TCC = Php2,000
Total Ordering Cost

TOC = (D ÷ EOQ) (OC)

TOC = (50,000 ÷ 2,000) (80)
TOC = Php 2,000
It can be observed that at the EOQ level, the
TCC and TOC are equal.
Total Inventory Cost

TAIC = TOC – TCC

TAIC = 2,000 + 2,000
TAIC = Php 4,000
 When to place
an order?

Determine the reorder point.

Reorder Point

A point in the inventory

level that requires placing
an order.
Factors in Determining the Reorder Point
• Lead Time – the time required between
placing of an order and its receipt by a
business
• Lead Time Usage – the number of units
demanded or consumed during the lead time
period
• Safety stock – the amount of inventory
maintained to reduce the risk of stockout.
Reorder Point (ROP) Formula
ROP =ALTU + SS
Where:
ROP – reorder point
ALTU – average lead time usage
SS – safety stock
Average lead time usage (ALTU) formula
ALTU = LT x (AU/UT)
Where:
ALTU – average lead time usage
LT – lead time
AU/UT – average usage per unit of time
Average usage per unit of time (AU/UT)
formula
AU/UT =
Where:
AU/UT – average usage per unit of time
D – annual demand
WD/Y – working days per year
Total number of orders placed in a year
formula
TNO/Y =
Where:
TNO/Y –total number of orders placed in a year
D – annual demand
EOQ – economic order quantity
Cycle time formula
CT =
Where:
CT – total number of orders placed in a year
WD/Y – working days per year
EOQ – economic order quantity
D – annual demand
Problem
Hyzel Manufacturing Company has an annual average requirement of 320,000
units. It has been estimated that the ordering cost is Php80.00 per order and that
the carrying cost per unit of inventory is Php20.00. It has 250 working days in a
year and maintains a safety stock of 6,000 units. It observes a lead time of five
days.

Required
1. Economic order quantity
3. Total ordering cost
5. Average usage per day
7. Cycle time
2. Total carrying cost
4. Total annual inventory cost
6. Reorder point
8. Total number of orders in a year
EOQ

EOQ
EOQ
EOQ units
Total Carrying Cost

TCC = AI x CC
TCC = (1,600/2) x 20
TCC = Php16,000
Total Ordering Cost

TOC = (D ÷ EOQ) (OC)

TOC = (320,000 ÷ 1,600) (80)
TOC = Php 16,000
Total Annual Inventory Cost

TAIC = TCC + TOC

TAIC= 16,000 + 16,000
TAIC = Php 32,000
Average usage per unit of time (AU/UT)
AU/UT =
AU/UT =
AU/UT =1, 280 units per day
Reorder Point (ROP)
ROP =ALTU + SS
ROP = (AU/UT x LT) + SS
ROP =(1,280 x 5 days) + 6,000
ROP = 6,400 + 6,000
ROP = 12, 400 units
Cycle time
CT =
CT =
CT = 1.25 working days
Total number of orders placed in a year
formula
TNO/Y =
TNO/Y =
TNO/Y =